Re-election Relaxation

THE RE-ELECTION OF PRESIDENT George W. Bush proved to be the pivotal fulcrum in a tense week, the passing of which drained risk perception from the option market.

Stock investors were anticipating a Bush win, or at least an end to the bitter presidential race, and had begun buying shares about a week before the nation went to the polls. But as the stock benchmarks crept up, implied volatility of the major stock indexes did not relax, as they often do in stock rallies.

That changed with the Nov. 3 opening bell, less than two hours before John Kerry conceded the election. Money managers unwound index option positions, particularly puts that they had shored up to guard against market uncertainty. Implied volatility of the major stock indexes declined markedly toward their year lows, and the Chicago Board Options Exchange volatility index, or VIX, fell 13% Wednesday. And there were few buyers even as option premiums slipped -- an indication that traders now see fewer immediate catalysts that can drive big stock-market moves.

"What the [option] market seems to be saying is that, going forward, people may be moving money from one sector to another, but the broad-based indexes aren't going anywhere," said Susquehanna Financial Group option strategist Robert Wilson on Wednesday.

That ebb in the volatility forecast would continue the rest of the week, as investors contemplated a benevolent tax policy and possible migration of Social Security money into the stock market. But the velocity of the decline slowed, and when VIX on Thursday dipped briefly below 13 -- near its 2004 and nine-year low -- buying picked up among those who think index options may have become cheap enough. VIX finished Friday at 13.84, down 15% for the week.

Nearly six million options changed hands both on Wednesday and on Thursday -- that's two busy individual-trading sessions. The heaviest call-trading occurred in specific segments and stocks people think might benefit under a second Bush term, including large pharmaceuticals, oil, money managers, defense and managed care.

Despite the gush of bullish jockeying, it wasn't hard to find evidence of caution. At the International Securities Exchange, the largest market for trading stock options, investors bought just 1.23 new calls for every new put on Wednesday -- the most restrained rate in 10 days and well below late-October levels, when this leg of the stock rally kicked off. The pace of call buying would pick up gingerly Thursday, but still seemed slightly out-of-sync with the buoyant buying in the stock market.

Of course, sentiment-sensitive contrarians might regard such moderation as a welcome sign -- proof there might still be money on the sidelines to power stock prices higher. But skeptics asked if the outlook for corporate profits have improved enough to blast the stock indexes from their recent trading ranges, and many strategists reminded investors to protect stock gains as the Standard & Poor's 500 pushed to a 2004 peak Friday.

So what can we look forward to now? The post-election volatility crush puts an exclamation point on the year's downward slide in risk perception, and ratifies the new regime of muted volatility. A number of traders and strategists say they believe stocks could -- barring surprises -- drift sideways or gradually higher until the economic outlook changes substantially. Meanwhile, VIX would flit spasmodically between 12 and 16 -- a hazy band within the lower half of its one-year range.

Despite the hushed volatility in the overall market, "every single week we still see individual stocks with volatility at or near highs, and where I think there's opportunity for localized, name-by-name volatility trading," says Andrew Kumiega, TD Securities' director of equity-option quantitative research.

The flourishing of these opportunities, Kumiega says, may be a by-product of Sarbanes-Oxley reforms that have fostered stricter corporate disclosures. "There are fewer leaks, more uncertainty," he says, "and the prices people are willing to pay for option protection appear higher" -- both ahead of anticipated events like earnings reports, or after unexpected news, like the recent recall of a painkiller.

So where are this week's pockets of pronounced volatility? Poring over technology companies, Goldman Sachs' option strategists zoomed in on stocks including
Cisco Systems
and Dell, which both report earnings this week. Option prices suggest traders are anticipating an 8% earnings-related stock move up or down for Cisco and a 6% Dell move.

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